Get With The Plan: June 15, 2014

Sam and Caryn are in their late 50s and plan to have an active lifestyle in retirement. They want to hike and ski — as long as they can, they say — and travel throughout the U.S. and overseas.

If their future retirement budget can handle it.

“We’ve put our three children through private colleges and they are now on their own out of state,” says Caryn, 57. “We’d like Sam to retire in two years and me in one, and we want to know if it’s possible.”

The couple, whose names have been changed, have saved $832,600 in 401(k) plans, $168,300 in IRAs, $109,000 in a brokerage account, $24,000 in a money market and $58,000 in checking.

Caryn is also eligible for a pension worth $4,200 per month, and she can start taking that benefit today.

The Star-Ledger asked Peter McKenna, a certified financial planner with Highland Financial in Riverdale, to help the couple determine if their savings and pension will be enough to fund the retirement lifestyle they’re hoping for.

He says they’ve been diligent savers and restrained borrowers, but moving to stop work too soon could mean they will run out of money during their lifetimes.

“The financial plan that models their situation has an 80 percent probability of success if they retire as desired at 58 and 59 respectively,” McKenna says. “That is too low a probability of success for us to recommend this approach, but there are good alternatives.”

He says if they delay retirement a couple more years — until Sam is 62 and Caryn is 61, their probability of success increases to 98 percent.

But some small changes could create a plan that’s closer to their goal of an earlier retirement.

The current plan calls for $8,000 per month of expenses, funding a new car every five years and spending $15,000 per year for travel for the first 15 years of retirement.

“Caryn’s pension covers more than half of the projected living expenses today,” McKenna says. “The pension does not have a guaranteed cost of living feature, so it is a fixed amount for life.”

This means as their expenses increase with inflation, the pension stays the same. At age 70, the pension will only fund 39 percent of their expenses, and at age 80, it will only fund 29 percent, he says.

“Inflation is a bigger threat to retirement than most realize, which is why maximizing inflation-adjusted Social Security benefits is key to this plan,” he says.

More on that in a moment.

McKenna says they can increase the probability of success of their plan by altering their expectations around auto replacement. Without the wear and tear of regular commuting, they may be able to replace one vehicle every seven years instead of every five years.

“Instead of working three years beyond their original goal this small change would allow them to retire two years later and still achieve a 95 percent probability of success,” he says.

Looking at their investments, McKenna says their success rate is based on a balanced portfolio consisting of 60 percent stocks and 40 percent fixed income. Using projections based on historical returns, this portfolio has an expected annual return of 7.5 percent, McKenna says.

But the current portfolio has more volatility than their risk tolerance would suggest is appropriate, and the expected returns are not high enough to meet their objectives.
McKenna recommends they sell much of their U.S. large-cap investments and add new asset classes, including small-caps, international and emerging markets stocks, foreign bonds, real estate and commodities.

“While the names may seem ‘riskier’ than U.S. large companies, the small percentages in each of these markets will reduce the overall volatility of the portfolio while providing the long-term returns their plan requires,” he says.

The couple also has about 10 percent of their investable worth in the stock of Sam’s employer.

“While this is common, having investment and employment risk tied to a single company exaggerates the impact of the company’s fortunes on their financial lives, making the good times better and the bad times worse,” he says, recommending they reduce or liquidate the position and invest in a more diversified mutual fund.

“This sale could have significant tax impacts, so determining when to recognize any gains should be part of the analysis,” he says.

He also says they need a closer look at the expenses charged by some of the funds they own.

As they near retirement, McKenna says they should both continue funding their retirement accounts to the max, while saving any surplus cash flow.

Long-term care insurance is something they should consider because a sudden need for care could derail their plan, McKenna says. Sam has a form of long-term care insurance through his father’s status as a military veteran, but Caryn has none.

“They currently have life insurance policies in effect, but with the exception of the small mortgage, there doesn’t appear to be a need for this life insurance,” he says. “The premiums on those policies could be redirected to long-term care insurance that is more valuable to their plan.”

Now, Social Security.

McKenna suggests they use a strategy called “file and suspend,” where the spouse with the greater benefit files for benefits at full retirement age but doesn’t draw against it.
By suspending the higher benefit, it will continue to grow at 8 percent per year until age 70.

“Even though this spouse is not yet drawing a benefit, the lower-earning spouse can now collect a spousal benefit of 50 percent of the top earner’s benefit. This could be more than their own benefit,” he says. “The increased amounts on the higher earner can then be drawn from age 70 as retirement or survivor’s benefits for as long as one of them is alive.”